Exchange-traded notes to lose tax edge in House proposal

Exchange-traded notes (ETNs), which mimic investments in securities without an annual tax bite, would lose that edge under a proposal from the top Republican tax writer in Congress.

Representative Dave Camp, a Michigan Republican, wants to require mark-to-market taxation of derivatives. Through that system, ETN holders would determine the products’ value each year and pay taxes at ordinary income rates on any change, even if they haven’t sold the securities.

“Structured notes are really a creature of the current tax code,” said Daniel Crowley, a partner at K&L Gates LLP in Washington and a former lobbyist for the Investment Company Institute, which represents mutual funds. “Otherwise, there would be no reason for them to exist.”

Camp is incorporating a draft of his plan into a broader overhaul of the U.S. tax code. His proposal on derivatives would have wide-ranging effects in the financial world. The change would sap enthusiasm for exchange-traded notes, which have attracted about $17 billion from U.S. investors, according to data compiled by Bloomberg.

Lawyers, accountants, investors and market participants have been trying to determine the probable winners and losers under Camp’s plan since he released it Jan. 24. Sage Eastman, a spokesman for Camp, said there is no estimate as to whether the proposal would increase or reduce tax revenue.

Proposal’s Purpose

Camp said he’s proposing the tax-code modernization to keep up with changes in financial products and make the rules simpler and more fair. He has also said his bill would curb Wall Street’s ability to hide and disguise risk by using derivatives.

Lawyers are still parsing the potential effects on convertible debt, straddles and futures markets. So far, the financial industry’s representatives in Washington have been relatively quiet about the proposal.

Scott Talbott of the Financial Services Roundtable, Will Acworth of the Futures Industry Association and Lauren Dobbs of the International Swaps and Derivatives Association declined to comment on Camp’s plan.

The Securities Industry and Financial Markets Association has been gathering input from its members and plans to provide feedback to Camp that emphasizes potential unintended consequences, said Payson Peabody, managing director and tax counsel at the Washington-based group.